Funding cost drop poised to lift Indian bank margins

Some Indian banks are expected to report wider net interest margins in the July-September quarter after the Reserve Bank of India's recent liquidity injections pushed down short-term funding costs, four bankers said.

The RBI has conducted open-market bond purchases and dollar-rupee buy-sell swaps over the past month, adding more than ₹1.5 trillion of durable liquidity into the banking system. That has driven down rates on certificates of deposit and interbank call money, the bankers said. Three-month CD yields have fallen about 35 basis points since mid-June, narrowing the gap between what banks earn on loans and what they pay for wholesale deposits.

Banks that rely heavily on short-term wholesale funding stand to benefit most, the bankers said. State-owned lenders and smaller private-sector banks have the highest proportion of such borrowings. For a typical mid-sized bank, a 30-basis-point drop in funding costs can lift the net interest margin by 8-12 basis points, one banker estimated.

The liquidity-driven margin relief comes at a time when loan growth remains robust at around 14-15%, partly due to strong demand in retail and services. Deposit growth has lagged, forcing many banks to compete harder for bulk deposits and pushing up term deposit rates. The RBI's liquidity operations have eased that pressure, the bankers said.

Lenders with large low-cost deposit franchises, such as HDFC Bank and State Bank of India, have less exposure to wholesale funding and thus less room for margin expansion from this channel, two of the bankers noted. For those banks, the primary driver of margin remains the pace of repricing of existing loans and the mix of high-yield advances.

The broader macro transmission is working as the RBI intended. The central bank wants lower short-term rates to feed through to lending rates, especially for small and medium enterprises and housing. The bankers cautioned that a full pass-through would depend on individual banks' asset-liability structures and their willingness to cut lending rates without squeezing margins.

The RBI's next monetary policy committee meeting is scheduled for August 6-8. Most bankers expect the committee to hold the repo rate steady at 6.75%. The tone on liquidity management will be closely watched. Any signal of further durable liquidity injection could extend the current decline in short-term rates, a third banker said.

For now, the margin outlook for the September quarter is brighter than it was in April, when tight liquidity pushed up funding costs. The bankers expressed cautious optimism, noting that the benefit could be one-off unless the RBI sustains its liquidity support through the rest of the year.